Economism: Bad Economics and the Rise of Inequality

First and perhaps foremost, people do not make decisions in the hyperrational manner—based on full and accurate information—that underlies Economics 101. Government intervention makes a lot more sense when people would not otherwise become well-informed, for example regarding the precise nature of risks in the financial securities that they buy. Location 87

Second, politics matter. Again, this is an obvious thought, but it is typically completely missing from the first year of economics (and, to be honest, often from some later years also). If you can capture the government or persuade officials to see things your way, this can be worth billions of dollars. Financial regulation has failed repeatedly and in many countries precisely because the regulators became too close, in their worldview, to the people over whom they were supposed to be watching. Location 93

Third, more devious strategies also work well. Create misperceptions of quality and you can overcharge people. This is obvious to you in a grocery store, because you can figure out at home the same evening if items are overhyped. But did you know that some important parts of professional money management operate on exactly the same basis? Principal-agent theory may sound like irrelevant jargon, but in fact the core idea—that the people you hire do not necessarily have your best interests at heart—is the dominant organizing principle of modern finance. Location 97

Fourth, the distribution of income can be tilted in your favor. Modern international trade deals are incredibly detailed and complex. Companies work long and hard to get a seat at or close to the negotiating table, to frame the issues in their favor, and to make sure they have enough votes in Congress to get what they want. Location 101

In the United States, the average family makes only 8 percent more money (after adjusting for inflation) than it did in the early 1970s, and even that meager increase is due to the fact that more people work today, whether by choice or by necessity; median income for men has actually fallen. Location 178

In the 1950s, a typical CEO of a large company took home as much money as twenty average employees; today he makes as much as two hundred workers. The percentage of families in poverty has remained essentially unchanged for the past half century.13 A rising tide no longer lifts all boats. Location 180

Note: It’s not really a big problem that the rich are richer or that a CEO makes more than he did 30 years ago. It’s just that it tells us that the richer the top get, doesn’t at all mean it will “trickle down” and make us all better off. They just get richer. Fine, but say that. Enough with the jobs shit or that it will make us wealthier.

This invocation of basic economics lessons to explain all social phenomena is economism.* It rests on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an Economics 101 textbook, even though the assumptions behind those diagrams virtually never hold true in the real world. Location 194

Note: In short, the proposal on the efficient market hypothesis and Libertarian economics rely on assumptions that do not exist in the real world.

This elegant model, however, rests on a set of highly unrealistic assumptions. The definition of a competitive market requires that all suppliers offer the same product—there are no differences in features, quality, or anything else—and that each company is so small that its behavior has no effect on overall supply. If this assumption does not hold—such as in the market for cell phone service, or air travel, or automobiles, or books, or almost anything—then supply and demand do not necessarily produce the optimal price, and the alLocation of resources may be distorted. Location 221

Note: Now we are in the important part, the description of the faults of the premises of “perfect markets.”

The argument that a minimum wage increases unemployment assumes that employees are currently being paid the entire value of their work; otherwise, employers would be willing to pay slightly higher wages in order to keep them. Again, this premise is unlikely to be true in the real world of fast-food restaurants or hotels, where workers have little bargaining power and companies are therefore able to claim most of the value that their employees create. Location 226

Note: That pretty much locks up the minimum wage argument right there for the most part.

Economism ignores these uncooperative facts and assumes the necessary assumptions, reducing all real-world questions to simple models and answering them in the same terms. Location 229

Note: Very good phrasing for Libertarianism. It reduces the complexity of the very complex real world into profoundly simplistic assumptions that never, in a pragmatic sense, bear out in the real world, where poeple live.

Communism and nationalism were popular because they were timely: each provided an explanation of the world that appealed to the interests of an important interest group. Today, economism is the perfect way to justify our new gilded age. “The fortunate is seldom satisfied with the fact of being fortunate,” Weber wrote a century ago. “Beyond this, he needs to know that he has a right to his good fortune.”20 Many people feel uncomfortable driving past slums on the way to tropical beach getaways. What they need is a model of society in which the inequality they observe is part of a larger design that works to the betterment of all people. Location 234

Economism presents a clean, uncluttered picture of the world stripped to its bare essentials, which can be communicated quickly and easily, dispensing with messy and uncooperative facts. If you are trying to understand the world, this is a major failing. If you are trying to win a debate, it is a huge benefit. Location 283

economists often use as their starting point for thinking about an issue. Even economists who favor the minimum wage, for example, will begin by considering how it affects the supply of and demand for labor. But they don’t stop there; they study the differences between the real world and the assumptions of the model, develop additional theories that take those differences into account, and test those theories using empirical data. Location 302

Note: There us a difference between a model and the way the world really works

Most advanced economics, you could say, is about making distinctions between abstract markets and the real world. Industrial organization deals with markets in which the assumption of perfect competition does not hold. Environmental economics is devoted to goods that are not optimally “produced” in an unregulated market. Behavioral economics illustrates the ways in which people violate the assumption of rational behavior. Location 305

“Academic reputations are built on new and imaginative demonstrations of market failure,” writes the economist Dani Rodrik.28 To take just a few examples: George Akerlof, Michael Spence, and Joseph Stiglitz won a Nobel Prize for showing how information disparities affect market outcomes; Robert Shiller won a Nobel Prize for research demonstrating that securities markets can be driven by irrational investor behavior; and Elinor Ostrom won a Nobel Prize for describing how real-world institutions can solve certain problems better than abstract markets. In each case, their theories build on the models taught in Economics 101 to provide a richer, more accurate description of behavior. “Although economists believe in markets in general,” writes the economist Mark Thoma, “they are continuously identifying instances of market failure and then designing government policy responses that can make these markets work better.” Location 308

Note: Market Failure,

Economism is what you are left with if you learn the first-year models, forget that there are assumptions involved, and never get your hands dirty with real-world data. This is one case in which a little knowledge is a dangerous thing. Location 335

The problem is that the popular case for free markets is too often applied unthinkingly to virtually the entire sphere of social interaction, with little or no regard for the complexity of the real world. Location 341

So who’s right? If the supply is truly fixed, then higher prices will not encourage more suppliers to enter the market, so the question is purely one of distribution: Who gets the shovels? The price mechanism decides based on people’s willingness to pay, which is partly based on the benefit they receive from a shovel but also reflects how rich they are. So the venture capitalist who works at home can afford a shovel, but not the single mother who will be fired if she can’t get to work. In most cases, we rely on prices because alternate means of distributing goods have their own problems: Could you imagine if the hardware store asked people to apply for snow shovels by explaining how much they needed them? But sometimes, when it comes to particularly valuable products, we don’t allocate them via the price mechanism, because most people agree that wouldn’t be fair. During the 2009 H1N1 influenza pandemic, for example, vaccines were distributed in the United States by the Centers for Disease Control and by state agencies with the goal of targeting people in high-risk groups, such as pregnant women—instead of letting the price system allocate the vaccines to rich hypochondriacs. Location 487

It’s not hard to win debates by making these simple arguments. It’s a lot easier to make a case in the abstract world of supply and demand curves than it is in the real world of people and institutions. That’s a major reason why economism is so widespread and powerful. But it’s the real world that we live in, not a textbook. Location 519

According to Keynes, on the level of the economy as a whole, leaving markets to operate on their own can create a vicious cycle of underconsumption by households and underinvestment by businesses, resulting in “a chronic condition of sub-normal activity for a considerable period”—such as the Great Depression. (Keynes even criticized “the celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who…teach that all is for the best in the best of all possible worlds provided we will let well alone.” He continued, “It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.” Location 600

The remainder of this book examines the impact that economism has had in these domains—most often to the benefit of businesses and the wealthy and to the detriment of ordinary families. Location 1116

In the past several years, a new round of sophisticated analyses comparing changes in employment levels between neighboring counties also found “strong earnings effects and no employment effects of minimum wage increases.” (That is, the number of jobs stays the same and workers make more money.) Location 1217

The idea that a higher minimum wage might not increase unemployment runs directly counter to the lessons of Economics 101. According to the textbook, if labor becomes more expensive, companies buy less of it. But there are several reasons why the real world does not behave so predictably. Although the standard model predicts that employers will replace workers with machines if wages increase, additional laborsaving technologies are not available to every company at a reasonable cost. Small employers in particular have limited flexibility; at their scale, they may not be able to maintain their operations with fewer workers. (Imagine a local copy shop: no matter how fast the copy machine, you still need one person to deal with customers.) Therefore, some companies can’t lay off employees if the minimum wage is increased. At the other extreme, very large employers may have enough market power that the usual supply-and-demand model doesn’t apply to them. They can reduce the wage level by hiring fewer workers (only those willing to work for low pay); a minimum wage forces them to pay more, which makes it profitable for them to hire more employees. Location 1223

In the above examples, a higher minimum wage will raise labor costs. But many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.*2 Justin Wolfers and Jan Zilinsky identified several reasons why higher wages boost productivity: they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better.15 A higher minimum wage motivates more people to enter the labor force, raising both employment and output.*3 Finally, higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs. All of these factors vastly complicate the two-dimensional diagram taught in Economics 101 and help explain why a higher minimum wage does not necessarily throw people out of work.16 The supply-and-demand diagram is a good conceptual starting point for thinking about the minimum wage. But on its own, it has limited predictive value in our much more complex real world. Location 1232

The idea that minimum wage hurts the poor is an example of economism in action. Economists have many different opinions on the subject, based on different theories and research studies, but when it comes to public debate, one particular result of one particular model is presented as an unassailable economic theorem. (Politicians advocating for a higher minimum wage, by contrast, tend to avoid economic models altogether, instead arguing in terms of fairness or helping the poor.) This happens partly because the competitive market model taught in introductory economics classes is simple, clear, and memorable. But it also happens because there is a large interest group that wants to keep the minimum wage low: businesses that rely heavily on cheap labor. Location 1272

According to an analysis by the sociologists Bruce Western and Jake Rosenfeld, one-fifth to one-third of the increase in inequality between 1973 and 2007 results from the decline of unions. Location 1304

However, the simple principle that pay equals marginal product has little to do with how the world actually works. It certainly isn’t true for the economy as a whole. In the United States, growth in wages closely tracked increases in productivity from the late 1940s until the early 1970s; since then, however, wages have risen much more slowly than productivity.44 This divergence highlights the possibility that pay levels are determined by negotiating power, not pure productivity. Location 1370

Instead, business is a team sport: not only is it impossible to quantify a single leader’s marginal product; it’s hard even to describe it clearly.45 Because no one knows what a CEO is worth, her pay is whatever she can convince her corporation’s board of directors to give her. This is hardly an arm’s-length negotiation, however. The CEO is usually the most powerful person on the board to begin with. In half of Fortune 500 companies, the CEO serves as the chair of the board. Even without that title, a CEO still has disproportionate influence because of her knowledge, her relationships, and the fact that she is difficult to replace quickly. A savvy CEO can recruit allies and place them on the compensation committee, which recommends her compensation package, typically based on an analysis of similar companies—a comparison group that can be weighted toward those with highly paid CEOs. The committee invariably proposes to pay at least as much as the median comparable company, because no board wants to admit that its company has a below-average leader. Some portion of the package will be linked to certain performance targets, but the CEO can encourage the committee to select metrics that will be easy to satisfy. Location 1376

Note: There is a good CEO argument there for ya

The economist John Kenneth Galbraith described it perfectly: “The salary of the chief executive of the large corporation is not a market reward for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.” Location 1388

As with the minimum wage, there is a serious debate among economists about whether CEOs’ pay is related to the value they provide their companies. While leaders matter, says the management professor Sydney Finkelstein, “luck also plays a much bigger role than anyone wants to talk about.” A 2001 study by Marianne Bertrand and Sendhil Mullainathan found that high CEO pay is often the result of dumb luck. For example, they found that heads of oil companies were paid more when profits increased, even when those profits were simply due to rising oil prices. Location 1391

And often what separates the winners from the also-rans is just a matter of luck. So many things can go wrong between founding a company and eventually going public that, even if an entrepreneur does everything right, success still depends on her company’s ability to dodge the slings and arrows of outrageous fortune—cancellation of early customer projects, departure of key employees, economic recession, and so on. In a survey by the Kauffman Foundation, 73 percent of entrepreneurs agreed that good fortune was an important factor in their start-ups’ success.53 Founding technology companies is a little like playing the lottery—and no one would claim that lottery payouts are determined by the winners’ marginal productivity. According to the Economics 101 labor model, Bill Gates’s enormous wealth must be the result of his superhuman productivity. Anyone familiar with the technology world, however, recognizes that it is largely owed to timing, good fortune, and mistakes by his competitors. In any case, we should question a model in which Gates’s work was worth billions of dollars a year while the work of Tim Berners-Lee, the inventor of the modern Internet, was worth virtually nothing by comparison because he never founded a company. Location 1444

Why should ordinary people care about whether or not corporate CEOs and fund managers really deserve to make hundreds as opposed to tens of millions of dollars? First, poorly designed pay packages can have harmful effects both on the companies paying them and on the economy as a whole. Excessive compensation reduces profits for shareholders, a group that includes not just the wealthy but also ordinary people whose retirement funds are invested in the stock market. Location 1463

Note: Zero Sum Economics, Rich off poor

In addition, awards linked to short-term targets that can be manipulated by insiders can cause executives to make decisions that maximize their bonuses but harm the company in the long run. For example, if a CEO is evaluated based on her company’s quarterly results, she may boost profits by reducing expenditures on research and development—investments that only pay off years later. More worryingly, the allure of massive bonuses was one reason why major financial institutions were so eager to take on risk in the years leading up to the recent financial crisis. From mortgage brokers whose commissions were based on the value of the loans they originated to CEOs whose stock awards were closely tied to their banks’ stock price, people responded to these compensation plans by pumping up deal volumes and placing increasingly one-sided bets. This tremendous appetite for risk helped inflate the housing bubble and ensured that when it finally collapsed, some of the world’s largest financial institutions collapsed along with it. Location 1467

In theory, the United States already has a progressive tax system, which means that the wealthy are supposed to pay a higher percentage of their income than the middle class—but things don’t always work out that way. The federal tax rate on income from work can be as high as 39.6 percent, but the rate that applies to income from investments is much lower: up to 20 percent for most capital gains (profits from selling something for more than it cost) and dividends (cash payments by corporations to their shareholders). Most income is also subject to a 15.3 percent payroll tax that funds Social Security and Medicare, but the bulk of that tax only applies to income up to $120,000, so it consumes a larger portion of pay for the working poor than for the well-off. The picture gets more complicated still when you consider things like tax-preferred savings accounts, carried interest, or fancy tax shelters. The bottom line is that although many rich people do pay a lot to the Internal Revenue Service, it’s quite easy for someone like Buffett, who makes his money from investments, to pay a lower overall tax rate than ordinary working people. Location 1518

Granted, most textbooks recognize that the government must be funded somehow, because it is necessary to maintain a market system (by paying for police, courts, and national defense, at a minimum). They also concede that a tax may occasionally correct for a market malfunction; for example, making people pay a little more for gasoline, natural gas, and electricity could prevent them from burning too much fossil fuel. Location 1553

But is it true? Take Warren Buffett, who made his vast fortune through investments. This is what he thinks: I have worked with investors for 60 years and I have yet to see anyone—not even when capital gains rates were 39.9 percent in 1976–77—shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. Location 1667

On its face, this seems obvious. If you can buy something—a house, a share of stock, a company, whatever—for $100 when you think it is worth $200, why wouldn’t you? A higher tax rate reduces your expected profit, but we’re talking about people who can already consume anything they want to and still have large amounts of money left over. At the very high end of the wealth distribution, people invest most of their money because there’s virtually nothing else they can do with it. Location 1672

Or, on a much smaller scale, take me. In 2001, five friends and I founded a software company. At the time, I didn’t even know what the tax rates on labor income and investment income were, and I doubt any of my colleagues bothered to check. We started the company because that’s what we wanted to do, not because the tax system encouraged us to do it. Location 1676

Anecdotes cut both ways, of course. Gregory Mankiw, as mentioned earlier, says he turns down moneymaking opportunities because of taxes. As with any economic issue, it’s more valuable to look at real-world data than to rely solely on theory or individual opinions. Location 1679

First, let’s ask whether taxes on investments really do reduce savings and therefore economic growth. Looking at historical data, this seems unlikely. As Figure 5.318 shows, taxes on investment income have fallen precipitously in the United States over the past seventy years, with no obvious increase in either savings or growth. On average, the economy expanded most rapidly in the 1950s and 1960s—a period when the tax rates on most investment income were 70 percent or higher—and most slowly in the first decade of the twenty-first century, despite much lower tax rates. Personal savings rates have also been declining steadily since the early 1970s, even as taxes on investments have fallen. Location 1681

Note: And there it is. The almost final and single paragraph destruction of supply side economics. It even avoids all argument of the reasons behind post War growth because if the lowered post 2000 taxes and no commensurate growth. Now we need to look at hiring and unemployment to go along with it.

But there are many reasons why taxes have less impact on savings and capital formation than predicted by the model. First, many people are like I was: they are blissfully unaware of their tax rates, which therefore cannot affect their savings decisions. Second, higher taxes on investments may cause middle-income families to save more, because now they have to put away more money to build up the same retirement nest egg. Third, behavioral economists have revealed that most human beings’ financial decisions are based not on sophisticated calculations involving rates of return but on primitive rules, such as “save whatever is left over after expenses” or “save 10 percent of the amount on my paycheck,” which are not affected by tax rates. Fourth, when it comes to the very rich, many seem to want to amass as much wealth as possible, so higher taxes will not motivate them to save less and consume more.22 Finally, even if cutting taxes on investments did increase personal savings, lower tax revenues increase the amount of money that the government has to borrow—reducing the capital available to the private sector.23 In short, the simple model saying that lower investment taxes will increase savings and growth doesn’t hold up to scrutiny. Location 1703

Next let’s look at economism’s other prediction: that lower income taxes will cause people—the wealthy in particular—to work more, stimulating the economy. Figure 5.424 tells essentially the same story as Figure 5.3: the top tax rate on labor income has been falling over the long term with no corresponding increase in overall economic growth. Contrary to the theory, letting people keep more of their salaries does not always motivate them to work more. As shown in Figure 5.525, the average federal tax rate for middle-income households has been drifting steadily down, from around 19 percent in 1979 to less than 13 percent in 2010. However, the percentage of working-age adults in the labor force—either employed or looking for jobs—has not risen as a simple model would predict. Instead, we see only a modest increase in the 1980s followed by a steady plateau. Location 1714

Alternatively, instead of looking across time, we can compare different states that have different tax policies. Here, too, the economists William Gale, Aaron Krupkin, and Kim Rueben have found no consistent relationship between state tax rates and either employment or economic growth, and only a small impact on the rate at which businesses are started.26 The American Legislative Exchange Council regularly ranks states by their tax rates (lower is better, according to ALEC) and the size of their public sectors (smaller is better); states that receive top marks, however, do not grow any faster than other states. In Kansas, for example, since conservative politicians slashed taxes in 2011, economic growth and job gains have lagged the rest of the country. Location 1727

Note: Trickle down

In particular, the very rich—the “job creators”—are not more likely to respond to higher taxes by spending less time in the office. When Robert Moffitt and Mark Wilhelm studied the impact of the 1986 tax reform—which slashed rates on labor income—they found no change in actual hours worked by high-earning men. The CBO review also finds little support for the idea that the rich are more likely to abandon the workforce than the middle class because of higher taxes. Burman even concludes of the superrich, “Evidence suggests that their labor supply is insensitive to tax rates.”29 The wealthy do report less income when rates go up, but they don’t actually work any less; instead, they put more effort into avoiding taxes, for example by becoming more strategic about when they recognize income. Location 1741

Changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top statutory tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. Location 1750

Overall, the latest economic research indicates that raising tax rates will not suddenly push CEOs and hedge fund managers to take early retirement, nor will cutting taxes cause them to start working harder immediately. This shouldn’t be too surprising. People who already make tens of millions of dollars per year clearly don’t need to work in any meaningful sense, so they make trade-offs between labor and leisure differently from most people. Perhaps they work because they enjoy it, or perhaps because income and wealth are ways to keep score in a long-running competition with each other, but in either case tax rates are largely irrelevant. Location 1754

The easy-to-remember lesson that higher taxes shrink the pie for everyone turns out to be less true in the real world than on a whiteboard. In addition, economism’s exclusive focus on deadweight triangles and lost output is itself a shortsighted perspective cultivated by Economics 101 classes. In particular, it ignores the crucial question of what the government does with its money. Location 1759

The key here is the concept of diminishing marginal utility, which is an intimidating name for a commonsense idea. People generally gain utility by having more stuff—more food, more clothes, more toys—or at least most people behave that way. But the more you have of a particular thing, the less you benefit from getting even more of it. For example, a family moving from a thousand-square-foot house to a two-thousand-square-foot house gains enormous utility from the added space, while a different family living in a twenty-thousand-square-foot mansion might not even notice an extra thousand square feet. Similarly, $100 matters a lot more to a working mother making minimum wage than it does to Warren Buffett. As you gain additional units of something, each unit increases your overall utility by a diminishing amount. This concept applies to most things—think about eating five pieces of pizza in a row—but in particular it applies to overall wealth: an increase in your net worth from $1 million to $1.1 million will never be as significant as going from $0 to $100,000. Location 1766

Friedman, too, endorsed a government which maintained law and order, defined property rights, served as a means whereby we could modify property rights and other rules of the economic game, adjudicated disputes about the interpretation of the rules, enforced contracts, promoted competition, provided a monetary framework, engaged in activities to counter technical monopolies and to overcome neighborhood effects [externalities] widely regarded as sufficiently important to justify government intervention, and which supplemented private charity and the private family in protecting the irresponsible, whether madman or child. Location 1795

Many of these crucial services are clearly worth more than the tax dollars necessary to pay for them; without law and order, property rights, contracts, competition, and a monetary system, there wouldn’t be much of an economy to begin with. Location 1802

Note: One of many things to memorize to get you out of the gates against Anarchists. Most Libertarians and even minarchists will give you this much.

Of course, even though virtually everyone agrees that some government functions are more than worth their cost, there is no easy way to draw the line between services that destroy value and those that create it. Still, once we acknowledge that government spending is necessary, it’s no longer possible to justify tax cuts merely by pointing to the deadweight triangle, as many commentators and politicians do. Any economic losses caused by taxes have to be compared with the benefits of centralized programs chosen and controlled by democratic processes, which requires a complicated and fact-intensive analysis, not the sweeping pronouncements of economism. Location 1803

Note: Taxes

Taxes are the cost of organizing ourselves in a democracy rather than as a collection of autonomous individuals. “I like to pay taxes,” said the Supreme Court justice Oliver Wendell Holmes Jr. “With them, I buy civilization.”36 A government is simply a mechanism by which we organize certain aspects of society that we do not trust the private sector to look after effectively. And so the question of whether taxes are worthwhile depends on what functions we expect from our government and how well it fulfills them. Location 1808

Note: First pass against anti taxers and Litertaritards

Kenneth Arrow, one of the towering figures in modern economics, in 1963 wrote a canonical paper explaining why health care does not behave like a textbook market. The most obvious anomaly, he emphasized, is that we do not incur medical expenses regularly. In fact, we rarely need most forms of health care. When we do need them, we need them badly, however; illness itself can be costly, both in lost income and in reduced quality of life, even before the high cost of medical treatment. Because we are not regular consumers of health care, we lack both the knowledge and the experience necessary to be smart shoppers. If you are diagnosed with a severe condition, you may have to choose among a variety of treatments that meant nothing to you the day before while facing a huge degree of uncertainty about their outcomes.16 You can’t rely on your friends’ recommendations, because many medical situations are unique and even people who have recovered from similar illnesses are unlikely to know exactly why. If you do your own research on different treatments and providers, you will struggle to find useful information. As the health economist Uwe Reinhardt describes it, “The usual absence of reliable information on the quality and prices of health care available to consumers…effectively converts them into blind-folded shoppers in a bewildering shopping mall.”17 These are all reasons why people tend to put themselves in the hands of their doctors rather than trying to become experts themselves and why informed consumer choice is rare in the medical sphere. Location 1984

In the long term, the result can be worse health outcomes and higher total costs, particularly when people try to save money by cutting back on preventive care or medications for chronic illnesses. In his review of the empirical research, Jost found ample confirmation that “increased cost sharing can have adverse health effects.” One study found that when people were switched into high-deductible plans, their primary response was to cut back on prescription drugs for chronic conditions; this was true even when prescriptions were exempt from the deductible (that is, such drugs were covered before participants reached the deductible), indicating that people are not the rational value maximizers that consumer-driven health care expects them to be.21 In some cases, requiring people to pay more for medical care causes them to forgo valuable services or treatments. Higher levels of cost sharing make poor families several times more likely to skip seeing a doctor for their children’s asthma and are also correlated with a higher frequency of asthma attacks among children. Location 2011

But if someone is likely to need $50,000 of health care, the appropriate price from the insurer’s perspective is more than $50,000, which most people obviously can’t afford. If you have a chronic illness, or your grandparents had expensive herary diseases, or you are simply old, the “correct” price could easily exceed your budget. Location 2037

If insurers set a profit-making price for each person, the poor and the sick will be left without any coverage at all. Ordinarily, we think that competitive markets maximize social welfare: remember, if people get something that they can’t afford, the economy will produce too much of it. But this is not necessarily true of health insurance, which enables people to afford medical care that could be of great value to them and to society. If someone couldn’t afford a needed heart transplant on her own, but her insurance policy pays for the operation, that’s not an example of frivolous overconsumption; that’s a benefit for society, particularly if she goes on to work productively for decades. Location 2041

In an ordinary market, the people who consume the most services should pay the most money; applied to health care, however, that principle would produce morally intolerable results. Therefore, in the real world, the market must be hemmed in by regulations that limit insurers’ ability to maximize profits and prevent individuals from opting out of the system. The point of all these constraints is to separate the premiums charged for a health insurance policy from the actual cost of underwriting that policy so that poor and sick people can buy coverage that a textbook market would deny them. This is how we end up with a barely tolerable system in which most people get some coverage at a price that isn’t too unaffordable. Location 2064

The more you rely on the principles of the market, the more you have to accept its distributional consequences. This is the fundamental problem with consumer-driven health care. Higher cost sharing makes economic sense, at least in theory—if we think that health care should be delivered through a market. It makes sense that price signals would encourage people to make smarter choices (leaving aside whether they actually behave that way) and force service providers to be more efficient. But if we rely on a competitive market to provide health care, then everyone will get the care that she can afford. For people who are steeped in Economics 101, this is a good thing; how else could we maximize social welfare? But for many people with traditional moral sensibilities, the idea that the rich will have access to life-extending therapies, the middle class will scrape by, and the poor will go untreated except in an emergency is simply wrong. “Most of us think it’s fine that some people can’t buy fancy clothing or fast cars,” the political scientist Jacob Hacker writes. “But most of us draw the line at basic health care.” Location 2078

Every other rich country in the world has a health-care system that is much closer to the single payer model than to the competitive market model, and they generally fare pretty well. Of the thirty-four countries in the OECD, only Chile relies more on private insurance and out-of-pocket spending to pay for health care than does the United States; in every other country, government spending, including social insurance systems, plays a larger role. On the whole, these countries enjoy health outcomes comparable to or better than those of the United States. Of the OECD countries, the United States ranks between twentieth and twenty-ninth on primary health status metrics, ranks in the bottom third for access to coverage, and has among the fewest doctors and hospital beds per capita.34 As discussed above, we earn these dismal results despite spending by far the most money on health care. Location 2131

Note: Again, when they say it’s because Americans eat too much ice cream or whatever “It’s your own fault” horseshit they’re in the mood for that say, explain it isn’t just health performance (maybe Americans lifestyle makes us unhealthier) but actual hospital beds per capita.

In this light, it seems quite possible that our high costs relative to the rest of the world are the result not of overconsumption but of a decentralized system organized around private profits rather than strong government spending controls.35 Finally, contrary to Friedrich Hayek’s dire warnings, public administration of health care has not led to an inexorable descent into totalitarianism. Location 2138

Note: Healthcare

Competitive markets and single payer reflect two different ways of thinking about health. On the one hand, we can think of health-care services as discretionary consumer purchases that should be allocated via the forces of supply and demand, which will ensure that resources are directed efficiently toward those people who value them most (in dollar terms). On the other hand, we can think of illness and injury as unpredictable, expensive risks that all of us face and that we have an equal right to be protected against. The remarkable thing is that American political debates and policy discussions are dominated by the competitive market model, with one side saying it should be wholeheartedly embraced and the other saying that it should be redirected through judicious regulations. Location 2143

With steady price increases making health insurance and medical care unaffordable for a growing number of families and businesses, one commonsense response would be to treat health care as a basic right that is collectively funded by all of society. Instead, policy proposals focus on making markets more efficient, which necessarily shifts costs onto the sick.39 The result is “rationing by income,” as Reinhardt puts it:40 the rich can afford whatever they need when they fall ill, while the poor may have to choose between medications, utilities, car payments, and rent. High out-of-pocket costs increase the financial strain on families when they are least able to withstand it; about one-fifth to one-fourth of all household bankruptcies are primarily caused by medical expenses.41 Our high level of income inequality may be more tolerable if all people can afford basic necessities, including health care. Today, however, low-income families are increasingly finding that even having insurance is not enough to pay for the services and medications they need, while the rich continue to enjoy the best care that money can buy. Location 2160

Complicated subprime mortgages would not have been possible in the “boring banking” system that lasted from the 1930s to the 1970s. With a traditional mortgage, a borrower would pay 20 percent down and then make monthly payments at a fixed interest rate for thirty years, after which she would own the house free and clear of debt. Only in 1982, with the passage of the Garn–St. Germain Depository Institutions Act, were most banks allowed to offer virtually any mortgage features they wanted, including adjustable rates, interest-only payments, or negative amortization.8 The Garn–St. Germain Act was in part an attempt to help savings and loan associations find additional revenues, because higher interest rates at the time were driving up their costs, but deregulating the mortgage market was also part of the Reagan administration’s larger economic program. Location 2274

Note: Reagan, deregulation, and the nascent embers of what would be the financial crisis of 07 and 08. Remember this act

Beginning in the 1980s, financial institutions developed dizzyingly sophisticated instruments for buying, repackaging, and distributing risk. The two most important were derivatives and securitization. Derivatives are essentially side bets in financial markets. A cr default swap (CDS), for example, is a bet that some company will or will not default on its debt. The buyer of the CDS makes a small payment to the seller every month; but if the company defaults, the seller makes a large payment to the buyer. Neither party to the CDS has to have any relationship to the company it is betting on. Location 2308

Securitization was the state of the art in repackaging and redistributing risk. Although just about any financial asset can be securitized, the most popular raw material was mortgages, particularly subprime ones. First, mortgage originators sold individual loans to investment banks (Merrill Lynch, Goldman Sachs, and so on).*2 The banks then created trusts—separate legal entities—which bought the loans. The trusts paid for them by selling mortgage-backed securities (MBSs) to a new set of investors (hedge funds, pension funds, mutual funds, and so on). MBSs, like bonds, are a promise to repay the investor at some point in the future, with periodic interest payments along the way. Each month, homeowners mail mortgage checks to the trust, which uses that cash to make the interest payments it owes to the MBS investors. Most important, these MBSs were tranched (“sliced,” in a combination of French and English). Each trust issued bonds with different levels of seniority. For example, there might be three tranches, labeled AAA, BBB, and C. (AAA, BBB, and similar designations are used by cr rating agencies to denote the riskiness of different types of bonds.) As money came in from homeowners, it was first used to pay interest on the AAA bonds; if all of that interest was paid, the next cash would go toward interest on the BBB bonds; and if there was anything left over, it would be paid to the holders of the C bonds. The most senior tranches were the least risky—bondholders were most likely to be repaid—and therefore offered the lowest interest rates; the least senior tranches offered the highest interest rates. Location 2328

Note: It’s not a knockout argument but it’s important information you wouldn’t want to get caught without. Fundamental to the financial crisis and useful for market failure

Federal legislators and regulators, seduced by the idea that large, sophisticated banks had mastered the art of managing risk and were unerringly steering capital around the economy, cheered on this transformation of the financial sector. Investment banks were only allowed to securitize mortgages in the first place because of the Secondary Mortgage Market Enhancement Act, passed in 1984. In 1999, Congress approved the Gramm-Leach-Bliley Act, which allowed investment banks, commercial banks, and insurance companies to combine into single firms for the first time since the 1930s. Gramm-Leach-Bliley rejected the long-held belief that risk-taking activities by investment banks could threaten the financial system. A year later, Congress passed the Commodity Futures Modernization Act, which, among other things, enshrined into law the nonregulation of over-the-counter derivatives. Location 2354

Then, in 2004, the Securities and Exchange Commission allowed the largest investment banks to use their own, internal models to calculate their capital requirements. The premise was that banks had an interest in measuring their risk accurately and had “developed robust internal risk management practices,” so they could be trusted to regulate themselves effectively. Location 2368

Only…as we have seen, this story ended in a tidal wave of collapsing housing prices, defaults, foreclosures, and countless stories of financial ruin. The most sophisticated financial system in world history, boasting computer power previously available only to the national security establishment, manufactured hundreds of billions of dollars of loans that would never be repaid. In addition to putting families out on the street, those loans caused massive overinvestment in residential real estate, funding vast exurban developments that stood vacant years later—an irreversible waste of real resources.19 As homeowners began missing mortgage payments across the country, the diversification promised by MBSs and CDOs turned out to be worthless: if borrowers are defaulting everywhere, the fact that an MBS is backed by mortgages from many different places isn’t much help. It turned out that MBSs and CDOs were in fact a large bet on the U.S. housing market—a bet that most financial institutions and many investors suddenly discovered they had placed. The very banks that orchestrated the housing boom collapsed or nearly collapsed along with the housing market in 2008, while investors ranging from midwestern school districts to small towns in Norway suffered crippling losses. Location 2383

Economism’s rosy model failed to predict how both individuals and companies would behave in a world of ever-increasing financial complexity. In the real world, people cannot always predict how much products will be worth to them, especially when it comes to complicated instruments like mortgages. Because a mortgage is one of the most important products that a person will select in her lifetime, poor choices can have serious long-term consequences. Consider the Option ARM, the emblematic mortgage of the subprime boom. In order to make a rational decision about an Option ARM, you would need to understand how the product worked, how much interest rates might go up, and the potential range of future housing prices (which would determine whether or not you could refinance in the future). In retrospect, it is clear that many borrowers during the housing bubble had no idea how much risk they were assuming. Most people taking out ordinary adjustable-rate mortgages—not even the fancy Option ARMs—did not realize how much their interest rates could rise. As Option ARMs became more popular, the vast majority of borrowers were making only their minimum monthly payments and were therefore highly likely to default when the teaser period of low rates ended. Location 2395

Note: Assymetric information and the literal impossibility of knowing how much a product is going to cost. It’s your own fault doesn’t help. It just tells us homo economicus fails and thus the perfect market assumption doesn’t hold up in the real world

Still, however, few people sought out Option ARMs. Instead, they had to be sold. Mortgage brokers actively pushed them onto customers by showing how low their initial monthly payments could be. Internal research by Washington Mutual, a large mortgage lender, indicated that people were more likely to buy an Option ARM if they knew less about the product; brokers often did their part by making sure that borrowers did not understand what they were signing up for. Common tactics included making up or doctoring information on applications, forging signatures, and pretending that adjustable-rate loans were actually fixed-rate mortgages.25 Even if people could qualify for low-interest-rate loans, brokers would steer them toward higher-rate products that paid bigger commissions; in 2005, more than half of subprime borrowers could have qualified for prime loans. Location 2414

Note: There it is. Unless you can somehow prove alll THAT was because of the government, Market Fundamentalism dies right then and there point blank.

In short, Option ARMs were popular because the financial industry wanted them, not because well-informed borrowers thought they were a good deal. The people buying and refinancing houses were not the customers; they were a source of raw material. The fact that ordinary human beings could not understand the legal documents they were signing was a crucial feature of the entire system, not a bug. According to economism, an unregulated mortgage market will maximize the number of value-creating transactions between buyers and suppliers of credit. Instead, the lack of regulation made it possible for millions of borrowers—aided and abetted by mortgage brokers and lenders—to take out loans they had little chance of repaying. The capital that flowed into Option ARMs and similar mortgages increased the number of buyers in the housing market, forcing up prices everywhere in an unsustainable frenzy that eventually produced the largest economic collapse in more than seventy years. Location 2427

Note: Probably as good of an opener for the financial crisis one can find. Watch them twist and parry and contort this I to “Governments” fault.

But anyone who has ever worked at a large company—or read Dilbert, for that matter—knows that corporations are not ruthlessly efficient profit maximization machines, but collections of fallible and often self-interested human beings. In economics, this is known as the principal-agent problem: the principal (company) can only act through agents (employees), who may not do what’s best for their principal.*4 Wall Street investment banks in particular are populated by highly competitive bankers, most of whose pay comes in an annual bonus that depends heavily on the fees they generated in the previous year. For the people who packaged and distributed MBSs and CDOs, those bonuses were based on the size of the deals they closed, not what happened later when housing prices started to fall. The immediate consequence of this compensation structure was apparent systematic fraud. Investment banks ignored problems with the loans they were buying from mortgage lenders, or failed to disclose those problems to the investors buying their MBSs and CDOs. As journalist David Dayen summarized, “The entire industry was assembled on a mountain of fraud” that began with mortgage brokers but continued on through the securitization chain.29 The goal was to transform as many mortgages as possible into securities that could be sold to end investors, without stopping to ask inconvenient questions. At the end of the housing boom, when those investors were getting harder to find, that even meant selling toxic assets to their own bank. Location 2446

Cr rating agencies such as Standard & Poor’s, Moody’s, and Fitch evaluate the riskiness of bonds, giving them grades like AAA, AA, A, BBB, BB, and so on, with the chance of default increasing as you move down the alphabet. These seemingly objective designations helped convince investors that MBSs and CDOs were safe investments. It was the investment bank managing a securitization, however, that chose the rating agency, which therefore had the incentive to keep the bank happy. According to one insider, the banks said, “Hey, if you don’t [give me the rating I want], the guy across the street will. And we’ll give him all the business.”35 That business was vitally important to the rating agencies, whose revenues grew rapidly during the housing boom. At Moody’s, executives who thought the firm was giving overly generous grades found themselves out of a job. After the crash, however, those same ratings came back to haunt the agencies; Standard & Poor’s, for example, later paid $1.4 billion to settle charges of grade inflation. Location 2493

Perhaps this should not be too surprising. Because economism’s arguments are rooted in pure theory, they can never be disproven by mere facts. Location 2542

“Some jobs are certainly being lost to imports—jobs in industries especially affected. But other jobs are being created by imports—jobs in industries producing the exports that are purchased by the dollars foreigners earn from the goods we import.”11 Meanwhile, everyone benefits from cheaper bananas (thanks to imports from Minnie). The same story reads differently from the perspective of the losers, however. When a rich country like the United States increases trade with a poor country, some industries will lose jobs because of competition from cheaper foreign labor. This can mean concentrated layoffs in specific sectors, as has happened to American manufacturing. Although those job losses may be balanced by gains in other parts of the economy, longtime assembly-line workers at automotive parts manufacturers in the Midwest cannot easily get hired by New Jersey pharmaceutical companies or Silicon Valley software firms. For them and their families, the direct impact of trade is long-term unemployment and financial hardship. The other losers from trade are workers in industries facing heightened overseas competition. Cheap imports, as well as the threat that American companies will send jobs overseas, reduce their ability to negotiate for higher pay, suppressing wages. Location 2717

In theory, because trade makes the total pie bigger for everyone, both globally and within any one country, there should be a way to redistribute some of the gains from the winners (consumers and workers in export industries) to the losers (workers in industries exposed to foreign competition). In practice, however, this would require an increase in taxes to pay additional benefits to the long-term unemployed—something that is virtually inconceivable in the contemporary American political landscape. As a result, the likely effect of international trade is to force concentrated groups of families into poverty and suppress working-class wages in certain industries while boosting high-end incomes and making everyone else slightly better off—ultimately increasing overall inequality. Location 2738

Second, individual workers and their families may never successfully adapt to the disLocation caused by lower-cost imports, especially if they live in areas dominated by industries vulnerable to foreign competition—such as the old industrial centers of Michigan and Ohio. This fact does not directly contradict the Economics 101 model, which recognizes that opening borders to overseas companies can create winners and losers. It demonstrates, however, that even if there are overall gains from trade in some aggregate sense—that is, comparing the benefits we all gain in the form of cheaper clothes, toys, and electronics with the harm suffered by laid-off workers—those gains come at the cost of increased inequality. Lower-skilled, less-educated people are most likely to lose their jobs or see their wages stagnate. As a practical matter, the United States has failed to help them share in the prosperity that is theoretically generated by increased international commerce. Meanwhile, corporations that can successfully export goods and services have become larger and more profitable, yielding even bigger paydays for their executives. According to the former Treasury secretary Lawrence Summers, “The view now is that trade and globalisation have increased inequality in the U.S. by allowing more earning opportunities for those at the top and exposing ordinary workers to more competition.” Location 2805

Instead of taking on faith that free trade produces the best of all possible worlds, we need to recognize that the more open our economy is to foreign competition, the more important it is to help displaced workers make the transition to new jobs. Because that transition is often difficult if not impossible, we need a more comprehensive safety net providing at least a minimum of protection from the hardships of long-term unemployment. Location 2913

To understand the rise of economism, we have to ask the key question of any crime novel: Who benefits? Let’s review. Economism helps suppress the minimum wage, lowering the wages of low-skilled workers and increasing the profits of restaurants, retail stores, and hotels. The argument that pay is based on individual productivity beats back efforts to constrain (or redistribute) the incomes of economic superstars such as corporate executives and fund managers. The idea that taxes are necessarily bad, and that taxes on high incomes and on investments are especially bad, has reduced the tax bills of the wealthy. At the same time, it has crippled the ability of the government to help ordinary families and created the budgetary pressure to scale back popular programs such as Social Security and Medicare. The fetishization of private markets has driven the idea of publicly funded health care to the margins of political debate, while the glorification of consumer choice has brought high-deductible health plans to the forefront—forcing poor families to make do with the coverage they can afford while allowing well-off, healthier families to benefit from lower taxes and tax-preferred savings accounts. The belief that cr markets should be as efficient as possible and that both individuals and firms can look after themselves brought large profits to financial institutions and unprecedented riches to their executives and employees but ultimately produced the most severe economic crisis since the Great Depression. The conviction that free trade makes everyone better off has diverted attention from the plight of working families “displaced” by foreign competition and camouflaged an international agreement that strengthens the rights of large corporations. Location 2984

Economism’s arguments usually favor the wealthy and businesses (which are largely owned by the wealthy), not ordinary families subject to the risks of unemployment, illness, or disability. In some of these cases, abstract economic arguments have had a causal impact: without the glorious simplification of supply-side economics, the Reagan and George W. Bush tax cuts might never have occurred; without Alan Greenspan’s soft spot for self-correcting, self-policing markets, federal regulators could have done something about the subprime lending boom. In other cases, economism has served to defend the status quo by making particular outcomes look like the inevitable result of natural processes. Location 2997

In a democracy, you might think that political outcomes would be determined by the preferences of the general public. You would be wrong. Considerable research has shown that when choosing between policies favored by ordinary people and those catering to the rich, the American political system sides with the money. According to an empirical analysis by Martin Gilens and Benjamin Page, average citizens’ preferences have almost no impact on whether a bill is passed, while the priorities of the very wealthy are much more likely to become law. “[Ordinary citizens] have little or no independent influence on policy at all,” they find. “By contrast, economic elites are estimated to have a quite substantial, highly significant, independent impact on policy.” Location 3050

Note: We live in an oligarchy

Like so much of Economics 101, however, the trade-off between efficiency and equity is harder to see in the real world than on the blackboard. Economists at the International Monetary Fund studied the actual relationships between inequality, redistributive policies, and growth and found the opposite: when other factors are controlled for, higher inequality (after taking into account redistributive policies such as taxes and transfers) is associated with slower economic expansion, and redistribution itself seems to have no impact on growth. They conclude, “On average, across countries and over time, the things that governments have typically done to redistribute do not seem to have led to bad growth outcomes, unless they were extreme. And the resulting narrowing of inequality helped support faster and more durable growth.”13 The implication is that reducing inequality would actually make the pie bigger for everyone, as well as producing a division of wealth and income that most people would consider more fair. Location 3080

Note: Inequality and inefficiency, the eternal argument. If this is beaten it’s possible we would be invincible

For a society to become rich, competitive markets are not enough; there must also be pluralistic, democratic political institutions that prevent elites from monopolizing power, suppressing competitors, and seizing an excessive share of resources. In this model, inequality is not a harmless by-product of a dynamic economy. Instead, inequality itself creates the risk that economic elites will dominate the political process and use their power to cement their position in society. Late medieval Venice, for example, was a hub of the Merranean economy and one of the richest cities in Europe. In the late thirteenth century, its semi-democratic political institutions were captured by a small group of wealthy families, who then used their power to monopolize long-distance trade. The city’s economic growth stagnated; today it is a museum. Location 3091

As elite groups use their political influence to cement their position in society, economism comes to their defense: inequality, it argues, is a natural feature of the best of all possible worlds, and therefore need not concern us. As John Kenneth Galbraith said, a conception of economics that ignores the role of power “becomes, however unconsciously, a part of an arrangement by which the citizen or student is kept from seeing how he is, or will be, governed.”15 By veiling the operation of wealth and power behind the symbolic imagery of markets, economism protects the existing order from democratic challenge. Location 3102

If we are to reduce the pernicious influence of economism in contemporary society, the first step is to call it out for what it is: a distorted worldview based on a misleading caricature of economic knowledge. One goal of this book has been to illustrate examples of economism in action, particularly for people who may pay undue respect to the logic of supply and demand. The competitive market model can be a powerful tool, but it is only a starting point in illuminating complex real-world issues, not the final word. The more that people understand the assumptions and limits of the model, the less likely they are to be swayed by its facile claims, which are incontrovertibly correct only on the Economics 101 blackboard. In the real world, many other factors complicate the picture, sometimes beyond recognition. Location 3107

Almost a century later, our productive capacity has grown about as much as Keynes predicted—in the United States, output per person is more than six times what it was in 1930—and robots are poised to do more and more of the work that human beings do today.20 We have the physical, financial, and human capital necessary for everyone in our country to enjoy a comfortable standard of living, and within a few generations the same should be true for the entire planet. And yet our social organization remains the same as it was in the Great Depression: some people work very hard and make more money than they will ever need, while many others are unable to find work and live in poverty. Location 3155

Note: This is the main reason we got into politics and economics, and is something that is just true and even Chris can’t disagree with. We have enough for every person to live well. Yet some poeple do almost nothing and have more than they can possibly consume. Some poeple cannot find work, or work themselves to physical collapse every day of their life to eventual death, and live in poverty.